Using gossip as an investment strategy

A source asked me the other day why I like gossip so much.

Aren’t reporters supposed to be solely dedicated to the facts? The danger of gossip is that much of it is false or half right.

It’s the reporter’s job to vet all the information coming in and separate the signal from the noise. Gossip is vital to keeping informed of big movements in the industry. Much of it is off base, but that’s why we work so hard to confirm information and talk to multiple sources on stories.

Beyond my own reporting, gossip may be an important component to an emerging investment strategy. That is the seeding/anchoring of spin-out managers. I’ve heard from a few firms that are either doing this exact thing, or are looking to add this type of strategy to their toolkit.

The idea is the investor backs a manager or group of managers who leave a bigger shop to start their own firm. This could include logistical support like helping to set up back-office functionality, advise on fundraising (but not actually raise capital), legal, accounting, etc; administrative-type functions that are necessary to the formation of a new firm but that take away from a new manager’s main goal of investing. In exchange, the seeder shares in management fees and carried interest for some specified period of time.

Whenever I chat with folks about this strategy, a question that comes up is: How do you find managers looking to spin out? I mean, short of being a mindreader, how do you figure out whom to talk to?

What I do is use my network of contacts to get a feel for who is thinking of making a move. This sort of gossip is always swirling around any industry, and I believe it’s imperative to be tapped into this flow of information. Sometimes one of those rumors turns out to be real. And suddenly you have information of high value. That’s when you get a reaction like, ‘he knew I was leaving before I did!’

This kind of information makes for great news, and it also could make for an interesting investment opportunity. A firm looking to seed the next great manager might get info on a talented young investment professional who voiced frustration about her current role, or expressed ambition about starting his own shop. The firm can try and get the inside track with the investment professional, even before they’ve actually left their shop.

For me, it makes a great story. For an increasing number of firms, it could mean making strong returns with the next great PE investor. This is why I like to remind everyone that I’m always around for a beer or coffee — swapping info.

Private Equity Editor Chris Witkowsky reflects at home. Photo by Wendy Witkowsky